The Grand Bargain

When you get rid of all the jargon that media economic commentators like to employ, what it all boils down to in layman’s terms is as follows:

(a) Ireland Inc is totally solvent, as it has now moved into a very hefty balance-of-payments SURPLUS, which every forecaster forecasts is going to grow and grow over the next few years. In this respect, Ireland is different to not only Spain, Portugal and Greece, but also to the U. Kingdom and U. States, all of which remain in hefty balance-of-payments DEFICIT.

(b) The economy is now extremely competitive, with a 12% gain in harmonised price competitiveness against the weighted average of competitor countries (not just the Eurozone since 2007). If residential and commercial property prices are taken into account, the gain in competitiveness is much greater. The excellent property economist, Ronan Lyons, had a piece on his blog last week showing how residential property in Ireland is now the cheapest in the EU by a proverbial mile (link below). This naturally drew an angry response from the Property Pinheads, but it confirms my own personal experience. Another recent survey showed that hotel prices in Ireland are now the cheapest in the EU. While energy prices have come right down to around the EU average. Wages have fallen, while rising in every other country. Productivity has risen (which even IBEC was boasting about the other week), resulting in unit wage costs falling even more dramatically.

http://www.ronanlyons.com/2011/03/16/is-irelands-property-market-competitive/

(c) As a result of (b), exports are now growing at peak-of-Celtic Tiger rates. As last weeks figures showed, exports ROSE by +9.4% in volume in 2010. In its December 2009 Stability Program, the Department of Finance had forecast that exports would RISE in volume by a miserable +0.5% in 2010, which low growth they attributed to ‘loss of competitiveness’, while in September 2009, both the Central Bank and ESRI had forecast that they would actually FALL in volume in 2010, so great was the ‘loss of competitiveness’. I posted at the time on this site (October 2009, its there if anyone wants to check) that these forecasts were complete nonsense, that the ‘loss of competitiveness’ was greatly exaggerated, and that exports would RISE by +10.0% in 2010. I was wrong. They only ROSE by +9.4%. I was very disappointed and embarassed to be so far out, but nonetheless +9.4% is a hefty RISE. In addition, the trend was increasing as the year progressed. In the second half of 2010, the volume of exports ROSE by +12.0% compared with the second half of 2009. And moving into 2011, the January and February PMIs for both manufacturing and services exports show this acceleration continuing. So, it looks like the RISE in export volumes in 2011 will be even higher than the +9.4% recorded in 2010. Naturally, the utterly useless Central Bank economists have learned nothing from their massive forecasting error for export volume growth in 2010 and, in order to get the stress test loss figure up as high as possible, are forecating that the volume of exports will RISE by a miserable +2.0% in 2010.

(d) As a result of (d), and notwithstanding the fact that consumer spending is flat, the economy is clearly growing quite rapidly again. Every business survey shows this. And last week came confirmation with the GNP figures. GNP has now RISEN for 3 successive quaters. It ROSE by +0.5% in Q2, by +1.5% in Q3, and by +2.0% in Q4, resulting in a cumulative RISE of +4.0% between Q1 and Q4. It would probably have been +5.0% but for the arctic weather in December. These are the figures for GNP, which every economist, in particular McWilliams, Kelly, Gugdiev, are on record as saying repeatedly are the ones that matter. They can hardly flip-flop now and say that the GNP figures don’t matter. This export-driven GNP growth is resulting in a very large fall in redundancies, a very large rise in vacancies, and the stabilisation or even very slight fall in the live register numbers. It may even be resulting in falling net emigration, if the recent QNHS population figures from the CSO are accurate (although I won’t linger too much on these, as ESRI are claiming that they are not accurate and we will have to wait until the census to see which of the CSO or ESRI are correct).

(e) Ireland is extremely politically and socially stable. The election results confirm that. TweedleFF lost out to TweedleFG. Quelle difference? Not exactly the revolution that the UCD Department of Sociology was hoping for? There was no lurch to extreme parties of the far right or far left. There have been ro riots, no strikes. It was London that was littered with broken glass on Saturday night, not Dublin. The number of days lost to strikes in Ireland in Q4 2010 was 27 (link below). Not 27 thousand, not 27 million, but 27. In France, the corresponding figure was 46 million. What this means is as follows: the GNP growth allready occurring makes it very likely that government budget targets will be achieved – but, in the unlikely event that they are not, the government will simply lop another couple of per cent off spending, and the public will accept it with little protest.

http://www.cso.ie/releasespublications/documents/labour_market/current/disputes.pdf

(f) Going back to Ireland’s IMF/EU borrowing, the GNP growth allready occurring, as shown by last week’s figures, explodes the myth that this imposes such a burden on the Irish economy that it can not grow, GNP growth of +4-5% in nine months is not to sneezed at. The corresponding UK figure was +1% growth. But, there is an additional point. As indicated in (a), Ireland is in balance-of-payments SURPLUS. That means it is accumulating assets faster than it is accumulating debt. Government borrowing is being exceeded by private sector saving. In a simpler world (not necessarily a better world, although that is a matter of opinion), the private sector in Ireland would simply lend to the government, just as was the case in the mid-70s and mid-80s when the budget deficit was similarily high, and as happens still in most other countries. The government would still make the same expenditure cuts and tax increases to reduce the deficit, but meantime the private sector in Ireland would fund the deficit. As I said, that would be a simpler world (not necessarily a better world). As is well known, this is not happening (thanks to the McWilliams/Kelly/Gurgdiev effect), and Ireland’s private sector is unwilling to lend to the government. Ireland’s savings are being invested abroad. I am just stating this as fact. I am not being judgemental about it. As a result, the government is having to fund the deficit, pending its reduction, by borrowing from the IMF/EU. But, as Gerry Adams once said of the IRA, Ireland’s savings haven’t gone away, y’know. Ireland’s savings are still there, they are simply being invested abroad, rather than being loaned to the Irish government. These investments are earning a return. That return has to be set against the interest repayments Ireland is making to the IMF/EU. If it earns a return greater than the IMF/EU interest rate, Ireland actually profits on the deal. Last week’s figures showed that this may well be happening. The profit flows moved in a favourable directions. Profits flowing back to Ireland rose faster than profits (including interest repayments) flowing out of Ireland. Whether or not this continues, the key point is that, as Ireland Inc is now in balance-of-payments surplus, the IMF/EU borrowing is not being used to finance Ireland Inc’s consumption, but Ireland Inc’s investment abroad. How good the deal is will depend on how good that investment abroad turns out to be and what return in profit flows to the Irish economy it will bring.

Coming back to John McHale’s point, it can be summarised as follows.

(a) All the fundamentals of the Irish economy are improving (balance-of-payments, competitiveness, relative price levels, exports, GNP growth, productivity, wage costs, political and social stability, net profit flows, redundancies, vacancies).

(b) We are deriving no benefit from this in financial markets because the media in Ireland and the numerous blog sites are currently dominated by politically-motivated, half-baked-revolution-seeking, half-mad quacks, who are arguing for Ireland to default, not because it is neccessary (the above figures show it is not), not because it would be beneficial (the above figures show it would not), but simply because it would advance their political agenda. They want to be in a position where they can say “Ah look, Ireland has defaulted, shows the whole system is corrupt, shows FF and FG are rotten, shows we need a complete break with the past and the total overthrow of the entire political edifice. Let’s have a revolution.” That is their agenda. It has nothing to do with economics.

As for what the new government should do, I suggest:

(a) Declare emphatically that there will be no default.

(b) To gain credibility in this position, highlight the points made in (a) to (f) above far more emphatically than either they or their predecessors have done so far. For this, they need to realise that the election is over.

(c) To gain further credibility in this position, appoint John McHale to Alan Ahearn’s role in the previous government, as he has consistently and convincingly argued against the default nuts.

(d) Default on the contract of employment with any economist in the public sector who advocates default.

@ JtO

Just a tiny point for clarification.

You say:

“Central Bank economists have learned nothing from their massive forecasting error for export volume growth in 2010 and, in order to get the stress test loss figure up as high as possible, are forecating that the volume of exports will RISE by a miserable +2.0% in 2010.”

Should that be ‘2011’ at the end of the sentence?

@Gavin Kostick

Should that be ‘2011′ at the end of the sentence?

JTO again:

Very well spotted for so early in the morning, Gavin.

Yes, it should be 2011.

@David O’Donnell

Blind Biddy wants to know if you respond to Novenas?

JTO again:

I’m Ulster Prod. We don’t actually do Novenas. But, I am sympathetic to the motivation of those who do.

@ John McHale

I think the attached link to the summary on Voxeu of the Professor Sinn, proposal which is largely reflected in the Grand Bargain, may provide helpful insights.

http://www.voxeu.org/index.php?q=node/6199

The charts are really quite startling. What they confirm for me is the phenomenon of the herd instinct of markets. In short, the markets are simply returning to the situation that existed prior to the introduction of the euro in relation to risk assessment in the sovereign bond markets. (The huge beneficiary is Germany in terms of the cost of borrowing).

The economic analysis of commentators such as Martin Wolf and Wolfgang Munchau is impeccable and highly informative. I find myself nodding in agreement and then, like a Chinese meal, I am left with a sense of dissatisfaction. It has only recently struck me that what may be the problem is the fact that the commentators in question have placed the fulcrum on the political and economic lever at the wrong point. The peripheral economies do not have the leverage they imagine they have and are not central, as their very name suggests, to the concerns of the major economies.The latter are sticking closely to nurse (Helga) and the markets cannot ignore this.

And, of course, the herd instinct plays its usual role. It is not that the market players think that the fundamentals of German banks, for the sake of argument, have improved but that they collectively have come to an understanding that the present sovereign risk premiums may be about right.

While waiting for the balloon to go up on D (for debt)-day, as I have just heard Joe Costello describe it, I wonder if the technically skilled bloggers on this site might not consider turning their thoughts to the real challenge; that of the necessary restructuring of the Irish economy. Pension reform is, in my view, the “Open Sesame ..” as any discussion makes unavoidable detailed consideration of all issues relating to the achievement of an egalitarian and productive society. The Swedish example is the one to follow except, maybe, the level of taxation. But an equilibrium can be found at a less intrusive state level.

@John TheOptimist

Blind Biddy: Ulster Prod or Black Prod ‘sall the same to me – I’ll lite the candles – shur aren’t we all Dissenters now? St John TheOptimist – pray for us – St John TheOptimist – hear us – St John TheOptimist – intercede with the ECB ferUS – St John TheOptimst – just give me one shot at &&^%%%$$$$$****

Old habits die hard – I’m outa here (-;

@JtO,

As usual you are assiduous and expansive in highlighting those factors that augur well for increased economic prosperity. That is to your credit – and gladdens the hearts of many in these parts. But you are equally adept at down-playing or ignoring those factors that restrict or damage economic performance. Perhaps you believe that there is excessive focus on the negatives and you see your role as providing some balance.

But you do yourself a disservice when you allege that those who highlight deficiencies in political and economic governance (and argue for reform) are part of a conspiracy to subvert the democratic process. There is no conspiracy of the nature and scale you allege. But there are many people who highlight the implications of the failure to develop the competing centre/right-of-centre and centre/left-of-centre blocs that are found in most mature, well-governed democracies.

In developed societies and economies the fundamental debate is about the role of the state. Those who are on the right generally favour less government (though the Neocom tendency is not averse to big government projecting economic, military and political power internationally); those on the left favour more government. Competing blocs of this nature with alternating periods of governance generally advance those policies that secure a democratic plurality while curtailing or reversing any excesses of their predecessors.

You are perfectly entitled to disagree, but there are many of us (both from the left, centre and right) who would argue that the political factional alignment (derived from a Civil War that by accident and design fomented these factions) combined with excessive executive dominance have contibuted much to the current debacle and requires reform. Villifying those of us who argue for these reforms is neither necessary nor helpful.

Reinhart and Rogoff say in a current paper that the scale of the bank debt buildup in Ireland and Iceland prior to the crisis, is in their view without parallel in the long history of financial crises – – 800 years in their celebrated book.

http://www.finfacts.ie/irishfinancenews/article_1021952.shtml

Looking back at the bubble years, the JTOs of that distant era were able to also conjure up sunny eternal scenarios with the help of ostensibly impressive FDI sector data.

Governor Patrick Honohan, Nov 2010: “With the structural shift towards high-productivity sectors during the 1990s and again since 2007, unit labour costs tend to fall even if wage costs for any individual firm or industry are increasing. Because of this shifting composition effect, as has been well-known for decades, but is routinely forgotten by superficial analysts, unit labour costs are a false friend in judging competitiveness developments for Ireland.”

It is well to remember that direct employment in the internationally tradeable goods and services sectors (FDI + local) is back at 1997 levels when the workforce was 25% smaller.

@ Seamus Coffey

So basically are you suggesting that MNCs are not repatriating as much profits as before?

@DOCM

Sinn is a great man for the ‘rules’ (as is Angela) – yet Ireland and Spain generally stuck to the rules [3 breaks to Fr/De at 6 each]

… dodgy-dodgy capital flows are another matter …. difficult to get Sinn and others in De to address this one … could be deeply cultural: De and other NornEU zwingliites – man is baad, moral hazard baaader, no debt forgiveness, burn in hell: hibernian & iberian lapsed catlicites – man is flawed, all is forgiven, what a gift, party on in heaven, send the cheque to the ECB and the zwingliites …

@DOCM

I’ve listened to Sinn – simply passing on a slightly tongue in cheek opinion (one which has some fuzzy merit imho – but have neither time nor resources to figure it out) … no reflection on your comment – a useful link …

Re the graphs returning to pre-euro_EMU nationals: markets simply following the present EZ logic, which is deeply structurally and politically flawed. EuroBonds are needed, and a further level of internal EZ control of financial flows across nationals … and an EZ wide restructuring of entire EZ financial system. ESM won’t do this job … and we don’t know where it’s going at the mo … ECB needs a new mandate ….. but no appetite for such moves by either Angie (wounded politically) or Nicky (fatally wounded politically as he tries to do a Maggie Malvinas in N Africa; he’s history if not yet) – and both for tactical political reasons setting on the Hibernians as a useful distraction from the state of their own financial systems – buys them time … we’re simply ‘collateral damage’ small, expendable, and control_able …. Where are our WMDs?

@ DOCM

‘The one asset that the Irish side could have brought to the table was a reinforced commitment to the measures required under the MoU. The new government, negotiating a joint programme in a world that no longer exists, did precisely the opposite’

That seems correct. The new government is not yet, and may not ever, be willing to face the opprobrium that would result from imposing a creditors’ regime on their electorate. The popular perception is that the proposed arrangement turns Ireland into one vast encumbered estate.

Whatever the merits of fiscal rectitude, such a scenario has inevitable historical echoes and will elicit the traditional resistance. The legitimacy of the decision to isses the blanket guarantee will be called into serious question, and various forms of resistance/evasion are likely to arise.

In the short term, we can anticipate a sharp tightening of the contingencies under which the bailout funds are disbursed. If the troika are as clear in their objectives as you maintain, the financial equivalent of a no-fly zone will have to be imposed on broad areas of government spending. The next review meeting should be fun.

@ Gavin Kostick

The Irish boy does not have his finger in the dyke except in the fevered imaginations of some economic commentators whose day will depart as quickly as it has come.

The view from the ECB, hot off the presses!

http://www.ft.com/cms/s/0/18dd0eb6-5ab8-11e0-8900-00144feab49a.html#axzz1I6m1dBDi

@ DOCM

‘It goes without saying that implementing the necessary reforms not only benefits the countries concerned, but is also an obligation for all governments so as to ensure that their economies function smoothly within our monetary union’

Naturlich. It’s all obvious really, from where Stark is standing. It’s funny, though, that he didn’t speak up before the credit bubble.

Oops, I should have but Q1 2009, Q2 2009, Q3 2009, Q4 2009 in my tables comparing the 2010 quarters with the 2009 quarters, instead of putting Q1 2009 for all four of them. I was intending to compare each quarter of 2010 with the corresponding quarter of 2009.

@Seamus Coffey

There is another important aspect of last week’s GDP figures that hasn’t received much comment. Perhaps Seamus Coffey could get his teeth into it in his blog, as he certainly seems very competent at analysing economic statistics. As far as I can make out, this is not related (or not much) to the net profits outflow figures that have been allready discussed on his blog and in some posts above.

The aspect that I have in mind is the unprecedented gap between the CIF figures for exports and the FOB figures in Q4 2010. The merchandise exports figures that are published each month (the next ones are due tomorrow) are on a CIF basis. But, in the GDP figures, they are on a FOB basis. The FOB figures are always less than the CIF figures, but usually by a relatively fixed percentage (4%, 5%, 6% – in that region).

These are the figures for Irelands’s merchandise exports, on both CIF and FOB basis, each quarter between Q1 2005 and Q4 2010. The figures are not seasonally-adjusted in either case, so are directly comparable. The CIF figures are from the monthly merchandise trade figures. The FOB figures are from the GDP and balance-of-payments figures. After each pair, I have calculated the FOB figure as a percentage of the CIF figure.

2005 Q1: CIF: 20,596.2bn – FOB: 19,500bn – %age: 94.7
2005 Q2: CIF: 22,194.3bn – FOB: 21,159bn – %age: 95.3
2005 Q3: CIF: 21,242.7bn – FOB: 20,161bn – %age: 94.9
2005 Q4: CIF: 22,699.2bn – FOB: 22,170bn – %age: 97.7
2006 Q1: CIF: 21,480.4bn – FOB: 20,393bn – %age: 94.9
2006 Q2: CIF: 21,585.9bn – FOB: 20,822bn – %age: 96.5
2006 Q3: CIF: 21,322.0bn – FOB: 20,474bn – %age: 96.0
2006 Q4: CIF: 22,383.7bn – FOB: 20,926bn – %age: 93.5
2007 Q1: CIF: 22,646.2bn – FOB: 20,992bn – %age: 92.7
2007 Q2: CIF: 22,924.8bn – FOB: 21,592bn – %age: 94.2
2007 Q3: CIF: 21,615.1bn – FOB: 20,053bn – %age: 92.8
2007 Q4: CIF: 22,039.9bn – FOB: 21,442bn – %age: 97.3
2008 Q1: CIF: 21,482.7bn – FOB: 20,019bn – %age: 93.2
2008 Q2: CIF: 21,762.0bn – FOB: 20,293bn – %age: 93.2
2008 Q3: CIF: 21,224.1bn – FOB: 19,666bn – %age: 92.7
2008 Q4: CIF: 21,925.7bn – FOB: 21,059bn – %age: 96.0
2009 Q1: CIF: 21,966.2bn – FOB: 20,331bn – %age: 92.6
2009 Q2: CIF: 22,133.5bn – FOB: 20,358bn – %age: 92.0
2009 Q3: CIF: 20,741.4bn – FOB: 18,408bn – %age: 88.8
2009 Q4: CIF: 13,397.8bn – FOB: 17,929bn – %age: 92.4
2010 Q1: CIF: 21,561.0bn – FOB: 20,477bn – %age: 95.0
2010 Q2: CIF: 22,722.9bn – FOB: 21,756bn – %age: 95.5
2010 Q3: CIF: 22,617.1bn – FOB: 21,592bn – %age: 95.5
2010 Q4: CIF: 23,090.4bn – FOB: 20,037bn – %age: 86.8

AS the quarterly figures show, the FOB to CIF ratio is normally around 94%, 95% something of that order. Sometimes a little above, sometimes a little below, but fairly steady. That is what one would expect, because, as far as I know, the way the FOB figures are calculated from the CIF figures in most countries is by applying a more or less fixed ratio to the raw CIF figures for each destination and category of exports. However, for Q4 2010, the FOB to CIF ratio has been reduced by the CSO to an unprecedented 86.8%.

The reason volume GDP fell in Q4 (but not volume GNP) is because the volume of merchandise exports supposedly fell in Q4. However, this was only on the FOB basis. On the CIF basis, from the monthly merchandise trade figures, we allready knew that the volume of merchandise exports increased in Q4 by around 4%, If the FOB figures had maintained their normal 94%, 95% ratio to the CIF figures, or even fallen to a very low 92%, 93% ratio, volume GDP would have risen significantly in Q4, instead of falling by 1.6%, and volume GNP would have increased by even more than the 2% figure the CSO gave. It was only the unprecedented fall in the FOB to CIF ratio to 86.8% that caused the volume GDP fall and limited the volume GNP rise to 2%.

I can only speculate as to the reaons why the CSO reduced the FOB to CIF ratio to 86.8% in Q4 2010. I am not suggesting for a moment that they did anything wrong, but it looks very freakish and will almost certainly be reversed in coming quarters.

One possibility is that it was reduced to compensate for being over-estimated on the high side in Q1 to Q3 2010. In those quarters, it was 95.0%, 95.5%, and 95.5% respectively, which is higher than in recent years. If that is the explanation, then it is quite likely that the quarterly GDP figures will beventually be revised. The total GDP figure for 2010 wouldn’t change much under this scenario, but the quarterly figures would, with the GDP figures for Q1, Q2 and Q3 being revised down, and the GDP figure for Q4 being revised up. This would bring the quarterly GDP trend for 2010 much more into line with the GNP trend (which shows GNP troughing in Q1 2010, then rising by 4% by Q4 2010).

Another possibility is that it is weather-related. There is a timing difference between the CIF and FOB figures, related to differences in time between when merchandise enters its port of departure in the exporting country and its departure from that country. It is possible that the artic weather in December affected the FOB figure, but not the CIF figure. If that is the explanation, there should be a big rebound in the FOB figures in Q1 2011 to match the growth we allready know (from the monthly trade figures) has occurred in the CIF figures.

However, this is just speculation. It might be some totally different reason that I haven’t thought of. Perhaps Seamus Coffey has more insight than I do. There does seem to be a general consensus in the media (e.g. Dan O’Brien said as much in the Irish Times) that the FOB figure for merchandise exports in Q4 will be revised up to bring it more into line with the CIF figure.